Bernanke: Derivatives Management Needs Help

The $62 trillion credit default swaps markets and other off-exchange financial instruments are not managed as well as they should be, Federal Reserve Chairman Ben Bernanke said Tuesday.

"The infrastructure for managing these derivatives still is not as efficient or reliable as that for more mature markets, as was evident last summer, when a surge in CDS trading volume greatly increased backlogs of unconfirmed trades," Bernanke said in remarks to a mortgage lending forum sponsored by the Federal Deposit Insurance Corp. The Fed chief's comments come as CDS dealers work on a number of systems to reduce credit risk, diminish backlogs and improve processing for these highly complex markets that are mostly unregulated. (Related Coverage: Credit to banks to be extended).

This issue was heightened with the near collapse of Bear Stearns earlier this year, as regulators and market participants feared the firm's CDS exposure was broad-based and would cause systemic risks in the market.

"The potential vulnerability of the financial system to the collapse of Bear Stearns was exacerbated by weaknesses in the infrastructure of financial markets," he said.

"Bear Stearns' counterparties on thousands of over-the-counter (OTC) derivatives contracts would likely have had serious difficulty promptly determining their vulnerability to counterparty losses," he added.

At present, a group of the major CDS dealers, accounting for roughly 90 percent of market activity, is working with the Federal Reserve Bank of New York to establish a clearinghouse.

Plans for that clearinghouse are still being mapped out and industry experts caution that there are some risks in centralizing credit risk into one entity.

The International Swaps and Derivatives Association is separately developing a system to help boil down the millions of trades that cancel each other out, which is expected to begin by the end of this month.